For all the grief I give Wall Street and its analyst denizens in our recurring column "This Just In," I must admit -- sometimes analysts have their uses.

Take, for example, Prudential. Skewered in our Jan. 22, 2007 edition for its record of making correct calls just 51% of the time (in fairness, a record since improved to 53%), Prudential's downgrade yesterday of dairy czar Dean Foods (NYSE:DF) holds little weight with me. Analysts -- just like the rest of us -- are notoriously bad at "timing the market." So when Prudential says that Dean's recent outperformance of the S&P 500 means the stock "is now in a digestion period" and it's time to take cash off the table, honestly, I could care less.

Meat 'n' cheese
Topping the list of reasons Prudential dislikes Dean today, the run-up in price constitutes the meat of Prudential's downgrade. But what interests me isn't the meat but the cheese. Literally.

Because almost as an aside to its main "hold" thesis, Prudential touched upon a longish-term trend that should interest investors more. Said the analyst: "The company's new goal of mid-teen's earnings per share growth ... appears achievable, but we believe there are short-term risks including volatile raw milk prices and uneven results for Horizon Organic."

That reference to "volatile raw milk prices" got my attention right quick.

Cows and corollaries
Long-time readers of the Fool will be aware that I've spent a fair amount of my time here studying the operations of a little company by the name of Lifeway Foods (NASDAQ:LWAY). In addition to sharing half a name with Dean Foods, the company shares other characteristics -- namely, a business devoted almost entirely to dairy, and a business greatly subject to the whims of the raw milk market.

After highlighting the stock as a growth story in the making back in 2003, I (along with many other investors, I imagine) watched in horror as Lifeway's business blew up in 2004. In Q2 of that year, the price of the raw milk from which Lifeway's trademark "kefir" beverage doubled, torpedoing profits. Granted, the carnage soon ebbed, as the price differential declined to just 25% or so in early 2005, and ultimately subsided entirely.

And here comes Prudential observing almost offhandedly that milk prices are on the rise once more.

Indeed. My thoughts exactly, and so I turned quickly to the friendly folks at the U.S. Department of Agriculture, who helpfully track the price of milk and publish it on the Web for all of us to see.

And what do we see?

  • A slight decline in the number of milk cows in the U.S.
  • Milk prices that actually rose 8% year over year in the first quarter of 2007.
  • Milk prices that are projected to rise as much as 14% for the full year, in comparison to 2006.

This could mean trouble, Fools. Because we appear to be just at the beginnings of a significant rise in the price of milk, I think it behooves us to watch this trend, track it, and begin weighing the risks to our portfolios. That's what I'll be doing over the next several months, as the milk trend firms up or evaporates. By way of introduction, here are a few of the companies I suggest investors keep an eye on as potential victims of a rise in milk prices, and why:

  • Dean Foods. Obviously, with more than 80% of its sales and profits coming from its dairy group, Dean is at risk here. As expressed in its most recent 10-K filing with the SEC, "Volatility in the cost of our raw materials can adversely affect our performance as price changes often lag changes in costs." Moreover, "We expect certain raw material prices, including raw skim milk prices, to increase in 2007."
  • Lifeway. Lifeway operates an even more milk-centric business than Dean, which also peddles bean juice, er, soymilk. Says Lifeway: "Cost of goods sold as a percentage of sales was approximately 54% during the first quarter 2006, compared to about 55% during the same period in 2005. This decrease is directly related to the decreased cost of milk during this period. The average cost of milk, Lifeway's largest cost of goods sold component decreased approximately 15% in the first quarter 2006 compared to the same period in 2005." If a 15% decline in the cost of raw milk translated into a percentage point of improved gross margin last year, it stands to reason that a 14% rise in the cost of milk will have the opposite effect.
  • General Mills (NYSE:GIS). You might think that a higher cost of milk poses just a corollary risk to the Wheaties maker. But consider, the U.S. retail segment provides nearly 70% of General Mills' revenues. And within that segment, a little thing called Yoplait yogurt has been General Mills' fastest-growing division in each of the last two years. Raise the cost of milk, and I'll bet you find that growth slows down.
  • Motley Fool Income Investor selection Kraft (NYSE:KFT). America spells cheese K-R-A-F-T. Need I say more? OK, I will. Dairy accounts for less than 20% of this $34 billion business. I don't expect the rise in milk costs to devastate Kraft, but it will probably have some impact.
  • ConAgra (NYSE:CAG). Do you own ConAgra? Lucky stiff. Last year, the firm marked its packaged cheese business as one of several "non-core" segments being held for sale. ConAgra should therefore dodge most of the risk in this sector.
  • Danone (NYSE:DA). Counterintuitively, the maker of Dannon yogurt is probably nearly as safe as ConAgra. Although it sells a lot of yogurt in the U.S., well over 80% of its sales are made outside the U.S. Keep an eye on worldwide milk trends, but unless they track the U.S., Danone should be safe.
  • Also-rans. Nestle, Yocream International, and Lucille Farms will all also suffer if milk prices go higher, but as pink-sheeted companies, I won't be paying as much attention to them. If you own them, however, consider yourself warned.

Milk. It does a body good. Let's keep close watch on this trend, people, and make sure it doesn't do our portfolios too much bad.

Do you have an opinion on any of these companies and their prospects should the USDA projections play out as portrayed in the report? Don't be a wallflower! Come on over to Motley Fool CAPS, and tell us who will be the winners and losers in this industry.

Fool contributor Rich Smith does not own shares of any company named above.